Until Friday, the stock market celebrated wave after wave of strong corporate earnings announcements and the market news seemed to cause a “melt up,” despite a huge snowstorm that paralyzed the Northeast. The Dow traded above 12,000 each day last week, but couldn’t manage to close above the psychologically important level. Then, on Friday, unrest in Egypt took the Dow down 166 points, while oil and gold surged. This week, I believe that rising earnings can drive the stock market higher, but only if tensions don’t spread from Egypt to other troubled lands. Stocks got off to a good start on Monday, with the Dow rising almost 70 points.
Rising Tensions in Egypt Torpedo Wall Street’s Winning Streak
The Dow was on target for its ninth straight rising week when the chaos in Egypt became a convenient excuse for nervous traders to take profits. There had been protests in North Africa over high food prices for many weeks, but when the ruling family of Tunisia was overthrown in mid-January, that seemed to give inspiration to neighboring nations to try to overthrow authoritarian rulers in Algeria, Egypt, Libya and Yemen. When the Egyptian government shut down the Internet and cell phone communications — which had been used to coordinate the protests — the world became outraged at this act of censorship.
One other factor putting pressure on global food prices has been the horrible floods in Queensland, Australia. Grains like barley and wheat were severely damaged by the floods, causing even higher wheat prices to fuel further protests in North Africa. In fact, Australia’s floods were so devastating that Prime Minister Julia Gillard opted to raise taxes to help pay for the flood damage. She raised the income tax rate by 0.5% on taxable income from $50,000 to $100,000 (Australian dollars) and 1% on income over $100,000.
Another factor pushing commodities up is the fact that Egypt controls the Suez Canal, which handles 7.5% of global trade, including 2.5 million barrels of oil per day. Europe’s refineries could be disrupted if the Canal is crippled or shut down. In addition, lots of grains and other food staples are shipped through the Suez Canal, which helps to put even more upward pressure on food prices in the region.
Before the Egyptian situation spun out of control on Friday, the impact of rising food and commodity prices was being hotly debated at the World Economic Forum in Davos, Switzerland. In particular, the European Central Bank (ECB) President, Jean-Claude Trichet, warned that rising food, oil and raw material prices could cause higher interest rates. For instance, on Tuesday, the Reserve Bank of India raised its benchmark interest rate 0.25% to 6.5%, its seventh interest rate increase since last March.
The good news on the commodity front is that, before Friday, crude oil prices had retreated from their recent highs to hit an eight-week low. Gold, platinum and silver prices had also fallen to their lowest levels in three months. But when the Egyptian government shut down the Internet and cell phones, crude oil and precious metals rose sharply as investors fled to these crisis hedges and other defensive investments.